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Ratio Call Spread

  • A neutral strategy that involves buying a number of calls at one strike and selling more calls at a higher strike
  • Similar to a ratio write but has less downside risk and lower investment cost
  • Has a range of profit
  • 2:1 ratio call spread: buy one call at 10 strike, sell two calls at 15 strike
  • Limited downside risk, unlimited potential upside risk, most profit if stock is exactly at the higher strike
  • Max profit = initial credit + difference in strikes or difference in striker - initial debit
  • Upside break even = higher strike + max profit
  • Higher ratio = higher credit = lower downside risk
  • Lower ratio = higher upside break even = lower upside risk

Ratio spread as ratio write

  • A deep in the money call can be substituted for the stock to simulate a ratio write
  • If the call is at parity i.e. has no time value, the profit potential for spread will be same as ratio write
  • Lower investment, lower downside risk
  • One downside is, ratio writer will receive dividend, spreader won’t

Ratio spread for credit:

  • One idea is to establish the spread with net credit
  • In this case there is no downside risk. If the stock collapses you keep the credit
  • There is still unlimited upside risk

Delta spread:

  • A completely neutral spread can be setup by using the delta of the calls involved
  • Example, long call delta 0.80, short call delta 0.50, a ratio of 8:5 will be neutral.
  • The idea with such a spread is to rely on time decay since the profit/loss will get cancelled by calls involved
  • Avoid ratios greater than 4:1, too much upside risk

Follow ups:

  • If the stock falls, the written calls can be rolled down. Not necessary if initial was credit
  • If the stock moves up, buy more calls to reduce the ratio